Group Properties of the Black Scholes Equation & its Solutions

Abstract: Several techniques of fundamental physics like quantum mechanics, field theory and related tools of non-commutative probability, gauge theory, path integral etc. are being applied for pricing of contemporary financial products and for explaining various phenomena of financial markets like stock price patterns, critical crashes etc.. The cardinal contribution of physicists to the world of finance came from Fischer Black & Myron Scholes through the option pricing formula which bears their epitaph and which won them the Nobel Prize for economics in 1997 together with Robert Merton and which constitutes the cornerstone of contemporary valuation theory. They obtained closed form expressions for the pricing of financial derivatives by converting the problem to a heat equation and then solving it for specific boundary conditions. In this paper, we apply the well-entrenched group theoretic methods to obtain various solutions of the Black Scholes equation for the pricing of contingent claims. We also examine the infinitesimal symmetries of the said equation and explore group transformation properties. The structure of the Lie algebra of the Black Scholes equation is also studied